Deja Vu All Over Again ? Hope No...but better watch out!

Just a few days ago at the beginning of February, banks in the US, Japan and Switzerland announced losses tied to troubled real estate lending while two bank leaders resigning. Shares of New York Community Bancorp (NYCB), fell, when the company disclosed troubles in its commercial property book and piled away millions of dollars for potential future losses.

Tokyo-based Aozora bank shares fell more than 20% after it said losses in its US office-loan portfolio will likely lead to a net loss. This would be its first loss in 15 years, while its president stepping down in coming April.

In Switzerland, CEO of a private bank, Julius Baer, resigned after the company took a roughly $700 million provision on loans that may not be recovered from Austrian property landlord Signa Group.

Underlying theme among these: Banks are big lenders to real-estate owners and developers, and they are on the front line of falling valuations of these properties that they lend to.

Risks are particularly high for small and regional lenders which have a higher concentration of commercial real estate loans in their loan portfolio.?

In previous newsletters, I had mentioned that we are living an era that is right after a very low interest rate regime which encouraged more risk taking by market players all around the globe and with the tightening actions by almost all Central banks around the globe, it seems like we are waiting for the next crises around the corner without exactly knowing its timing...

Well, It seems like Commercial Real estate in many geographies, but especially in US, enjoyed that low interest rate regime before Fed tightening. In US, $2.2 trillion of US commercial property loans are set to come due by 2027. Considering commercial property values on average decreased about 30% after pandemic compared to before pandemic values and commercial equity loans are usually offered up to 75% Loan To Value (LTV), even before “next crisis”, with current property values, many lenders would be facing potential losses if property owners stop payments. As these figures are on average, the severity of the problem would depend on the geography and to what extent the lending standards like LTV or magnitude of balloon payment amount have been relaxed. If, as in the example of Silicon Valley Bank; missing CRO example in 2023 regional bank crisis; other regional banks were missing their CRO’s either literally or figuratively, relaxed lending standards at the time would be generating losses now, That is why many small and midsize lenders in US are feeling the pain and although NYCB seemed like a winner in the regional banking crisis in US, who stepped in buying parts of failing lender Signature bank, announced that they are now setting aside $ 552 Million for future potential losses, largely from commercial property loan portfolio.

Are we going to see more of such bank statements in the news? in my opinion yes, because although fed cut rate is widely expected in second half of 2024, recent strong employment data suggest that rate cuts might be delayed, and it could take more time to get before pandemic level rates. This could mean that for commercial property owners, the likelihood of refinancing with better terms or finding a loan extension with suitable rates would diminish, thus non payments would be increasing given property values would be less than remaining loans and this would be increasing the pressure on banks and the financial system.

Can this result in a global crisis? Well in my opinion probably no, given the response of regulators in US to regional bank crisis in 2023, securing depositors of Silicon Valley Bank (SVB), Signature Bank and First Republic Bank. Depositors of small and medium sized banks would not most probably rush to these banks creating a deposit flight and liquidity run risk but given the already swollen Fed balance sheet which is about $ 8 Trillion, about 4 times higher than the 2008 Financial crisis QE action following the subprime mortgage meltdown in US, there would most probably be a limit to security level that could be given by FED. So it would all depend on the size and timing of defaults from small and medium regional banks $2.2 trillion of US commercial property loans for this to become a deeper issue and a global problem, but considering FED already has about $2.4 trillion of MBS left from 2008 crisis, it sounds like “a Déjà vu all over again” but what is an extra one or two trillion dollars on a $8 trillion balance sheet right ?

That is why I would like to think and hope that this would not be like before, but as mentioned at the beginning, a non-US lender, like Aozora bank in Japan demonstrated once again how the problems in one part of the world can affect other parts of the world…Long story, short… a simple recommendation: if not done yet by now, you would better increase risk management & governance capacity in your organization.

If you have any questions, please contact Alper Eker

[email protected]